We saved the world from disaster, Fed's Bernanke says

Without strong action by central banks, recession would have been much worse

WASHINGTON (MarketWatch) -- The global economy is now beginning to emerge from its worst crisis in generations, but the downturn might have been much worse if central banks hadn't acted so forcefully last fall, Federal Reserve Chairman Ben Bernanke said Friday.

In a speech at the Kansas City Fed's annual retreat in Jackson Hole, Wyo., Bernanke summarized a hellish year and explained modestly how he and his central bank colleagues saved the world from a bigger disaster. Read his full remarks.

"The world has been through the most severe financial crisis since the Great Depression," he said. "As severe as the economic impact has been, however, the outcome could have been decidedly worse."

If the Fed, other central banks and other government leaders hadn't acted in a coordinated and aggressive way in September and October of 2008, "the resulting global downturn could have been extraordinarily deep and protracted," Bernanke said.

Bernanke spoke to a selected group of top policy makers and economists. His speech, however, was aimed at a much wider audience: The president, the Congress and a public that's angry and confused.

Bernanke's term as chairman of the Fed runs out in January, and the financial world is watching to see if President Barack Obama reappoints Bernanke or hands to job to someone else.

Past financial panics have exacted an "enormous toll in both human and economic terms," Bernanke said. "In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation."

The policy response "averted the imminent collapse of the global financial system, an outcome that seemed all too possible to the finance ministers and central bankers."

Action plan

Among the actions taken by the Fed and other central banks:

The Fed lowered interest rates to close to zero. Other central banks lowered rates as well.

Congress approved the $700 billion Troubled Asset Relief Program to provide emergency financing to large banks. Other governments did the same with their banks.

Under the direction of the Group of Seven, government insurance for banks was expanded worldwide. Governments pledged to prevent the failure of systemically important banks, and they promised to provide adequate capital to the system.

The Fed created new facilities to "lend freely against sound collateral."

The Fed and other central banks began buying long-term debt issued by public and private institutions to inject liquidity to vital credit markets.

The Fed and the Treasury Department conducted a public "stress test" of large banks to determine their capital needs, which in turn was followed by significant increases in capital raised in private markets.

Bernanke's speech emphasized the policy response after the crisis erupted last September with the collapse of Lehman Bros. and the failure of other financial institutions, including Fannie Mae, Freddie Mac, American International Group, Merrill Lynch and Wachovia.

His history of the crisis essentially begins in September 2008, and ignores the actions and decisions that led to disaster. Of the origins of the crisis, Bernanke's only remark was that, until just before the crisis, "there was little to suggest that market participants saw the financial situation as about to take a sharp turn for the worse."

Bernanke made almost no comments about the future course of the U.S. or global economies, other than repeating phrases from the latest communique from the Federal Open Market Committee that the economy seems to be leveling out. He cautioned that any recovery is likely to be gradual at first, with high unemployment.

Use of some of the Fed's liquidity programs has declined, he said, a "clear market signal that liquidity pressures are easing and market conditions are normalizing."

He said nothing about how the Fed would unwind its support for the banking system. That day seems to be in the distant future, however. "Although we have avoided the worst, difficult challenges still lie ahead,' including securing a sustainable economic recovery and rebuilding the institutional framework to make sure a similar crisis can be averted.

Rex
Nutting

Rex Nutting is a columnist and MarketWatch's international commentary editor, based in Washington. Follow him on Twitter @RexNutting.

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